Lengthy investigation is common, official says

By Jennifer VigilUNION-TRIBUNE STAFF WRITER

January 10, 2006

As one of the federal investigations into San Diego's financial practices moves toward a courtroom confrontation, the city still is waiting for the Securities and Exchange Commission to end its regulatory probe.

Friday's indictment of five current and former pension system officials is the first major action taken by federal investigators since the SEC and the U.S. Attorney's Office began examining the city's finances two years ago.

That's when San Diego officials acknowledged they had made errors and omissions in securing more than $1 billion in bonds over an eight-year period that started in 1996. Those activities come under the jurisdiction of the SEC, which oversees the nation's private and public trade in stocks, bonds and other securities.

The commission's probe differs from the others – including a state case that resulted in criminal charges against six former pension trustees – because its targets are subject only to sanctions, such as fines and injunctions, and not criminal consequences like jail time.

But just because one investigation has entered a new phase does not mean the SEC probe is about to end, City Attorney Michael Aguirre said.

Mayor Jerry Sanders said San Diegans have lived with their "collective hearts in their throats" since the federal probes began, and there's no reason to believe they will soon see any resolution.

"At this point, I'm not confident that the SEC or any of this will come to a quick conclusion," he said.

The time involved is not unusual, said Peter Henning, a former attorney in the SEC's enforcement division.

"Two to three years is quite common," said Henning, a law professor at Wayne State University in Detroit. "And of course, this is sensitive, too, because you're talking about government officials, so there has to be concern about the effect on municipal government."

The indicted defendants – retired pension administrator Lawrence Grissom, system general counsel Loraine Chapin and former pension board members Cathy Lexin, Ron Saathoff and Teresa Webster – are charged with conspiracy and wire and mail fraud.

Lexin, Saathoff and Webster also are among the six waiting for a judge to decide whether the state's conflict-of-interest case, alleging they improperly benefited from their pension board votes, should go to trial.

The Byzantine entanglements spawned by the city's pension deficit – one of the main liabilities the city is accused of concealing from investors – include the criminal and regulatory investigations and a raft of lawsuits challenging San Diego's handling of its employee retirement benefits.

Aguirre, who has brought several lawsuits involving the pension system, also is part of ongoing talks with the SEC, which he said "are progressing in a very positive way."

He proposed that city officials move toward a settlement with the SEC in August, an idea that instantly drew criticism from several City Council members, who called the move a premature admission of guilt.

Nels Mitchell, an associate regional director in the SEC's Los Angeles office, declined to comment on any aspect of the San Diego probe or to confirm whether the agency has been in talks with city officials.

The SEC has investigated several public agencies, though those inquiries make up "a very small" number of the 500 to 600 enforcement cases it pursues each year, Mitchell said Friday.

One of the most prominent of those cases was Orange County, which 12 years ago filed for bankruptcy protection after the loss of $1.7 billion in faulty investments. It was the largest municipal bankruptcy in U.S. history.

That probe, ended by a 1996 agreement with the SEC, led to other settlements with local city agencies and school districts that had hundreds of millions of dollars in Orange County's investment accounts.

In the Orange County case, regulators found that 11 bond issuances worth $2 billion were illegal. The county's activities also drew the attention of other criminal investigators, and its former treasurer and assistant treasurer each served jail time.

At the time, the SEC's top enforcement official said municipalities "cannot misstate" basic financial facts to investors. "If they issue documents that are rife with misleading statements, public officials cannot say, 'It's not my problem,' " he concluded.

In Friday's indictment, prosecutors cite an e-mail exchange in 2002 between Webster, the city's former acting auditor, and Lexin, the former human resources director, in which Webster appears to be pushing to cover up the city's debt obligations.

In urging Lexin to delete a passage about the pension system from a public record, Webster wrote that the city "does not need to telegraph its pension problems to the rating agencies who don't research the topic to any great level now."

San Diego's revised bond disclosures revealed the breadth of its annual pension obligations, which at that time were projected to rise to more than $300 million by 2011. They also noted other expenses and accounting errors.

The corrections were prompted by letters from former pension trustee Diann Shipione, who earlier had warned that deals to underfund the pension system while increasing employee benefits could prove disastrous. The bond documents she reviewed were for a September 2003 sewer bond issue that was later abandoned.

Since then city financial statements dating to 2002 have been called into question, and San Diego, faced with declining credit ratings that would lead to higher debt payments, has not been able to issue bonds.

Disclosure violations can be severe enough for regulators to refer a case to criminal investigators, said James C. Spindler, who teaches securities law at the University of Southern California.

"If particular officials can be shown to have knowledge of what they were doing, intentionally putting fraud into these bond disclosures, they can go to jail for that type of thing," Spindler said.

Other SEC investigations of public agencies have led to penalties for private firms accused of offering misleading advice to public officials. Eight firms, including Merrill Lynch, were the subject of suspicion in the Orange County settlement.

A 1995 Massachusetts case resulted in $10 million in fines for Merrill Lynch and another firm.

Other cases have involved cities accused of misleading investors while issuing bonds.

Two Miami officials settled with regulators in 2000 after the SEC accused them of failing to disclose revenue losses in three bond sales in 1995 that raised $116.5 million. Syracuse settled with the SEC in 1997 after accusations it duped investors who bought $23 million in bonds. Syracuse's budget reflected a small surplus, when the city had a $9 million deficit, investigators said. A city auditor triggered the probe.

Most targets of the agency agree to abide by regulators' findings without admitting guilt. Some also have to submit to oversight by an independent monitor. Individuals also can be subject to fines or restrictions to their participation in the market.

The SEC has leveled substantial fines after investigations. Three years ago, 12 Wall Street firms paid nearly $1 billion to settle allegations that they had prepared overly optimistic stock reports to attract business from corporate clients.

Neither Miami nor Syracuse, however, was fined. That result is common, Henning said, because regulators do not want to punish taxpayers.

"I doubt that the commission would seek any kind of penalty from the city," said Henning, who also runs a Web log on white-collar crime.

"A city is very different. You're talking about taxpayer money. (Regulators) are a little reticent about shareholder money. They're very reticent about taxpayer money."

There could be costs involved in SEC sanctions, particularly if San Diego is ordered to submit to monitoring to prove it is abiding by the terms of a settlement. Taxpayers would have to pay that bill.

They already are on the hook for a lot of money. Sanders said Friday the pension deficit could be $2 billion, more than the $1.4 billion estimate pension system officials have used since 2004 because the 2005 evaluation of their books has been delayed.

Aguirre said the annual pension payment to reduce the debt could be $200 million to $300 million in the fiscal year that begins July 1, far more than the $165 million estimated by city officials. The city also has spent nearly $25 million on legal expenses and two independent investigations.

The problem, Henning said, is no government ever wants to appear "to go cheap" when trying to get out from under suspicion.

"You want to satisfy the government," Henning said. "You want it to go away so you can move forward."